Steven Sanders, CEO & Chief Investment Strategist
Philip Brown, CFA President & Equity Portfolio
QUARTERLY COMMENTARY, 4th QUARTER 2016
The economy ended the year on an optimistic note. Third quarter real Gross Domestic Product (GDP) grew at an above-consensus rate of 3.5% following two subpar quarters that averaged only 1.1% during the first half of 2016. Economic data indicates that consumer spending was still strong into the fourth quarter. December motor vehicle sales surged bringing total sales for the year to the highest level since 1999. Despite weak holiday sales reports from the "big box" retailers, such as Macy’s and Kohl’s, nominal retail sales managed to increase at a 6.8% pace in the fourth quarter.
Many expect 2017 to show even better growth than 2016. If GDP in the fourth quarter rises at an estimated 2.0%, growth for the year will be 1.6%. Currently, the average expectation for growth in 2017 is 2.3%. We believe that growth could be slower than the consensus forecast for the year.
The consumer sector has been the driving force for the economy. An improving labor market, rising income, and lower inflation have supported confidence and personal spending accelerated. Trends have already started to reverse which could slow growth in personal spending in 2017. Employee payrolls which grew an average of 229,000 in 2015, only added an average of 180,000 in 2016. Year-over-year inflation, as measured by the deflator for personal consumption (PCD), rose only 0.6% in 2015 due to falling energy prices. Through November, the pace has more than doubled to 1.4%. Even though the wage rate rose from 2.3% to 2.6% last year, the effect of higher inflation eroded purchasing power of those earnings. Real disposable income grew 3.0% in 2015. Through November, real income has slowed to a 2.3% increase over the prior twelve months. If energy prices continue to rise as many are forecasting, disposable income will erode further. It would take a fiscally irresponsible tax cut or inflationary wage gains to replace the lost real disposable income.
We do not expect any of the other sectors of the economy to accelerate enough to provide significant additional contribution to growth in 2017. The housing sector continues to recover, but the pace of growth has slowed and is unlikely to be strong enough to propel the total economy. Unless Congress passes significant tax incentives in the first half of the year, business investment should remain lackluster for the year as a whole. One potential area for additional growth is government spending. President-elect Trump promised increased infrastructure spending which could boost economic growth, but that would ultimately increase the size of the federal deficit, which in turn would hurt the financial markets. We do not expect a precipitous economic slowdown, but the markets could be disappointed.
Market Outlook & Trends
At approximately 2280, the S&P 500 index is hovering near its 52 week high of 2300. Based on current consensus earnings estimate (non-GAAP) of $130 for 2017, the S&P 500 is trading at approximately 17.5x, above its long-term historical average. The current estimate for 2017 of $130 (revised downward from $137 one year ago) compares to the estimate of $123 for 2016, implying growth of approximately 6%. It remains unclear if the new administration may enact legislation (e.g. tax reform) that could affect the current consensus outlook. Assuming EPS of $123 is achieved for 2016, it would indicate approximately 3% annual earnings growth. Considering estimates were revised downward during 2016, it remains unclear if earnings growth will accelerate to approximately 6% in 2017. In our opinion, we do not anticipate material multiple expansion from current levels unless earnings estimates are revised higher post Q4 2016 earnings reports. Furthermore, market volatility experienced in recent quarters may continue during the first quarter 2017.
Equity enthusiasm was reignited post the results of the presidential and mid-term elections in early November. While it remains unclear how the administration intends to legislate, investors assumed pro-growth measures may transpire. Despite modest economic data reported in recent months, investors adopted a ‘risk-on’ strategy, rotating capital into sectors that would benefit assuming deregulatory policies are enacted by the new administration. The post-election equity rally was lead, primarily, by cyclicals including Industrials, Energy, and Materials. Additionally, the assumption pro-growth policies may ignite inflation in future periods caused a rotation into the Financials. Recent enthusiasm may calm in the early part of 2017 as investors realize any legislative actions may take time to be implemented. Therefore, while we acknowledge the new administration may pursue progressive legislation, the timing and effects remain unclear, thus we believe maintaining a balanced investment view is prudent at the current time.
Among major geographies, the U.S. economy appears to be the most stable. As implied, assuming certain legislative actions are enacted over time, overall economic growth may be stimulated. We anticipate overall economic growth within the EU will remain relatively benign during 1H 2017 as the region deals with the separation of the U.K. Conditions in Asia remain mixed. Therefore certain industry sectors with a U.S. centric focus may offer more attractive growth prospects on a relative basis.
The Financials sector (particularly capital markets) may benefit assuming the regulatory environment is less onerous moving forward, and rates inch higher over time. The Energy sector may present select opportunities assuming commodities prices remain relatively stable and supply/demand is balanced appropriately; we believe certain companies within the Energy sector are more reasonably valued after approximately two years of industry rationalization. Recent indications post OPEC’s summit in December imply the consortium will act rationally near-term. The Industrials sector (cyclicals) may see some benefits assuming policies encouraging deregulation and more favorable tax rates are legislated. Sectors relying heavily on international trade must be scrutinized more closely assuming the new administration considers reviewing and evaluating current trade agreements. It remains unclear how the Health Care sector may be impacted assuming the new administration reviews and potentially alters current policies.
The views expressed in this report and accompanying communication are solely the opinions of StoneRidge Investment Partners LLC (the “Firm”). Although the statements of fact and data in this report have been obtained from, and are based upon, sources that the Firm believes to be reliable, we do not guarantee their accuracy, and any such information may be incomplete or condensed.
All opinions in this report and accompanying communication constitute the Firm’s judgment as of the date of this report and are subject to change without notice. This communication is intended for informational purposes only and does not constitute a solicitation to invest money nor a recommendation to buy or sell certain securities. Equity investments are not appropriate for all investors. Equity investments are not FDIC insured and may lose value. Investments in small, mid-cap and micro-cap companies involve additional risks such as limited liquidity and greater volatility.
Past performance is no guarantee of future results.
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